Sector Level Analysis of FDI-Growth Nexus: A Case Study of Pakistan

Transcription

1 The Pakistan Develoment Review 48 : 4 Part II (Winter 2009) Sector Level Analysis of FDI-Growth Nexus: A Case Study of Pakistan SOMIA IRAM and MUHAMMAD NISHAT * I. INTRODUCTION The most stable nature of Foreign Direct Investment (FDI) among the all caital inflows has rovoked its imortance esecially in case of caital scarce develoing economies. Economic growth is the indicator of the health of economy and caital is one of the rerequisites to maintain and enhance the momentum of growth. In the current scenario, growth of Pakistan economy has gone considerable changes and regarding these changes, Pakistan has adoted different olicies concerning different sectors of economy. Currently, the services sector share to GDP has imroved considerably against the dismal erformance of manufacturing sector over the last ten years. In order to enhance the economic growth effectively and efficiently, government has taken several stes to attract foreign caital. One of these measures is the adatation of highly liberalised olicies to attract most needed financial caital along with its sillovers. Even after suffering from obnoxious economic ailments, Pakistan in current decade is able to attract massive caital inflow erhas highest in the history. However, the massive inflow of FDI is directed towards services sector. Even after conducting a handful emirical research, the imact of FDI on growth is countervailing. Some early studies [Singer (1950); Griffin (1970)] recognised the negative imact of FDI on economic growth in develoing countries. Aitkin and Harrison s (1999) in case of Venezuela, Jhon and Athanasios (2004) in case of US and Western Euroean countries, and Katerina, et al. (2004) in case of transition countries found that FDI do not significantly affect economic growth. However, Blomstrom, et al. (1992), Caves (1974) and Kokko (1994) showed a ositive effect of FDI inflows on economic growth. Findlay (1978) highlighted the ositive effect through technology sillovers, which has the strongest otential to enhance economic growth in the host country. Borensztein, et al. (1998), Xu (2000) and Alfaro, et al. (2003) suggested the ositive imact of FDI in resence of the sound educational level, develoment of local financial markets, and other necessary conditions to absorb sillovers. Blomstrom and Kokko (2003) exlained that ositive effects of FDI are not automatic but the local conditions influence firms adotion of foreign technologies and skills. Borensztein (1995, 1998) exlained the growth enhancing effect of FDI through the channel of Somia Iram <somia_irum@yahoo.com> is MPhil Student at Alied Economics Research Centre (AERC), University of Karachi, Karachi. Muhammad Nishat <mnishat@iba.edu.k> is Professor of Business and Finance at Institute of Business Administration (IBA), Karachi.

2 876 Iram and Nishat technology. Borensztein (1995, 1998) emhasised the resence of at least threshold level of initial human caital for the diffusion of technology sillovers. Romar (1986, 1990), Helman and Grossman (1990) emhasised the imortance of knowledge caital, coming through research and develoment in the long run economic growth. According to Chudnovsky and Loez (1998), FDI may boost economic growth through the imrovement of manufacturing exort and imroved balance of ayment. However, in the long run, due to the control of foreigners over the local roduction resources, rofit outflow deteriorate the balance of ayment condition. In case of develoing countries, FDI mostly work through the channel of externalities. However, there is no definite conclusion related to sillovers of FDI. Benefits and cost associated with FDI is not disseminated homogenously across all countries and even across all sectors. Therefore, different countries, regions and even sectors react differently to same FDI inflow. Alfardo (2003) examined the effect of FDI on growth in the rimary, manufacturing and services sectors. The author suggested that total FDI exerts an ambiguous effect on economic growth. FDI in the rimary sector tends to have a negative effect on growth. However, investment in manufacturing tends to have a ositive effect on growth. Moreover, evidence from the service sector is ambiguous. Zaman, et al. (2008) investigated the factors effecting FDI in case of Pakistan using data over the eriod of , and found that variables used for market size and trade balance are significant, whereas, variable used for service sector has negative effect on the growth of economy. Imortance of FDI can not be denied, esecially in case of develoing economies. FDI not only allows overcoming the financing and liquidity constraints, but also rovide new caital, allowing additional investment in both human and hysical caital, which can be very beneficial for develoing countries. To the best of my knowledge, in case of Pakistan only few studies have investigated FDI-growth nexus. FDI-growth nexus is not being investigated with resect to services sector and manufacturing sector. Overall, the imact of FDI on growth can be misleading. This study is first attemt to investigate the imact of manufacturing sector and services sector FDI on growth in the resence of macroeconomic instability and rivatisation regime in case of Pakistan. The main objective of the study is to investigate the imact of services and manufacturing Foreign Direct Investment (FDI) on economic growth over eriod of 1972 to We decomose the FDI into services sector and manufacturing sector and examine their imact on economic growth. To further evaluate the role of FDI on growth in resence of rivatisation olicy, interaction terms of services as well as manufacturing FDI with rivatisation dummy is introduced. This aer is organised in to following sections: Section II regards the data, model and methodology; Section III contains results and conclusion, whereas, last section includes conclusion and olicy recommendation. II. MODEL SPECIFICATION AND DATA SOURCES To estimate the relationshi between FDI and economic growth at sector level, we estimate the following model:

3 Sector Level Analysis of FDI-Growth Nexus 877 Y t =δ o +λ 1 MFDI t + δ 2 SFDI t + δ 3 INV t + δ 4 INF t + δ 5 MFDI t *DUM t + δ 6 SFDI t *DUM t + µ (1) Where Y reresents the real GDP er caita, MFDI and SPFDI reresent FDI in manufacturing and service sectors resectively, INV reresents ublic sector investment and INF reresents Inflation rate roxied for macroeconomic instability and t reresents time eriod ( ). The Dummy of rivatisation is also included in this model due to its significance Data used in this aer is obtained from the electronic database of International Financial Statistics (IFS), Annual reort state bank of Pakistan. The FDI of selective sectors is chosen for the samle because of the unavailability of data in case of Pakistan. Data on services and manufacturing FDI is obtained from foreign liabilities and assets and investment in Pakistan (Various Issues). Before estimating the long run and short run results, ADF and PP unit root tests in order to check the unit root of all variables. We use the robust technique Autoregressive Distributed Lag model (ARDL) introduced by Pesaran, Pesaran, and Smith (1998), Pesaran and Shin (1999) and Pesaran, et al. (2001). The error correction version of ARDL model is given below: Y t 1 Yt i 2MFDIti 3SINVt i 4 INVt i i1 i0 i0 i0 5 t i 1Yt 1 2MFDIt 1 3SFDIt 1 i0 4 INVt 1 5INF t 1 t (2) INF Where 0 comonent and µ trend is the error term. The term with summation sign reresent the short run dynamics. While, the second art of the equation reresent the long run dynamics. In order to estimate the long run coefficients, the following long-run model is estimated: Yt i0 1 i1 Y t i ti t 2 i0 MFDI t 1 3 i0 SFDI t i 4 i0 5 INF (3) After finding the long run relation we use the following equation to estimate the short run coefficients: Y Y MFDI SFDI t 1 ti 2 ti 3 ti i1 i0 i1 ti 1 i1 i1 ti ti INV 3 INV INF EC (4) η is the error correction term in the model indicates the ace of adjustment reverse to long. t i

4 878 Iram and Nishat III. ESTIMATION RESULTS III.1. Testing of the Unit Root Hyothesis We alied ADF test and PP unit root test in order to check the unit root of all variables. The results suggest that all variables are having mix order of integration. A summary of the results of ADF and PP unit root tests is given in Table 1. Table 1 Unit Root Results ADF (Drift and Trend) P- P (Drift and Trend) Variables Level 1st diff Level 1st diff Y 2.08*** 3.45** 2.19*** 3.08** MFDI * * SFDI ** ** INV 2.89** 3.76* 2.78*** 3.94** INF * * Notes: *(**) Shows significance at 1 ercent (5 ercent) level. From the results of unit root tests, it is aarent that the variables have different order of integration. In the next ste, we roceed to aly the ARDL aroach. III.2. Autoregressive Distributed Lag Model (ARDL) Lag Selection The first ste of bound testing aroach is to select the order of the lag length. On the basis of lag length, we found the F-statistics value. The estimated F-value selected on the basis of lag length is given below: Table 2 Lag Length Selection and Bound Testing for Co-integration Lags Order AIC HQ SBC F-test Statistics * * 4.95** Short-run Diagnostic Test-Statistics Serial Correlation LM, F = 0.78 (0.19) Hetroscdasicity Test F= 1.92 (0.21) Ramsey RESET Test F= 0.65 (0.35) Normality J-B Value = (0.07) * Significant at 5 ercent level according to Pesaran, et al. (2001) and Narayan (2005). 1 We found that the otimum lag length is two, which is selected by using Akaiake Information Criterion (AIC) as shown in Table 2. At lag length two, the F- statistics is significant at 5 ercent level. The significant F-value indicates that there is co integration among the variables. After finding a long run relationshi we estimated the long run and short run arameters. The results of long run coefficients are given in Table 3. 1 Critical values are obtained from Pesaran, et al. (2001) and Narayan (2005).

5 Sector Level Analysis of FDI-Growth Nexus 879 Table 3 The Long run Results Deendent Variable Y ARDL (1, 1,2, 2, 2) Variables Coefficients MFDI 0.28 (0.02) SFDI 0.74 (0.03) INF 0.45 (0.06) INV 0.18 (0.04) MFDI*DUM 0.28 (0.08) SFDI*DUM 0.47 (0.04) R2 = 0.97 Adjusted R2 = 0.95 F-statistics = (0.00) Dh Stat = 1.97 The values in the arenthesis are the robability values. The results of the Table 3 show that all variables are significant and have exected signs. The ositive coefficient of FDI shows that real GDP er caita is largely deends on inward flow of FDI. However, it is aarent from the results that FDI inflow contributes to economic growth mainly when the economy ractices the rivatisation. The results show that FDI inflow in the service sector accelerates economic growth by a high seed. FDI inflow in the manufacturing sector significantly affects economic growth. However, the magnitude of SFDI is much greater than MFDI. Moreover, it is aarent from the results that FDI inflow contributes to economic growth mainly when the economy ractices the rivatisation. The reason behind this result is that rivatisation olicy in most countries has roved to be investor s friendly. Privatisation reduces the management bottlenecks. It enhances the efficiency by introducing new and advance management ractices. The coefficient of rivate investment (excluding foreign investment) is ositive and significant at 5 ercent level of significance, which is deicting the ositive effect of rivate sector articiation. In case of Pakistan both services as well as manufacturing sectors are contributing but services sector is contributing much more than manufacturing sector. In the current decade major surge of FDI was towards the telecommunication sector that has strengthened the infrastructure as well as increased job otential and in return caused increased contribution to economic growth. The error correction version of ARDL is resented in Table 4. Table 4 Error Correction Reresentation of ARDL Model Deendent Variable ΔY ARDL (1, 1,2, 2, 2) Variables Coefficients ΔMFDI 0.16 (0.17) ΔSFDI 0.36 (0.13) ΔINV 0.42 (0.07) ΔINF 0.24 (0.18) EC(-1) 0.42 (0.09) Adjusted R 2 = 0.89 F-statistics = (0.01) The values in the arenthesis are the robability values.

6 880 Iram and Nishat The sign of estimated lagged error correction term ECt-1 is negative and significant at 9 ercent level of significance. There is 42 ercent seed of adjustment towards long run equilibrium. In the short run, MFDI and SFDI do not significantly affect economic growth. In the case of develoing countries FDI is imortant because of its sillover affects that are not instantaneous rather time consuming that s why FDI do not contributes the growth in the short run but it takes time to influence the growth atterns of economy. The short run results show that inflation and investment significantly affect economic growth. The sign of inflation is ositive in the short run. This is due to the fact that an increase in the rices increases the rofit margin of the roducers in the short run. However, in the long run due to decreased real income of the general masses, economic growth hamers. IV. CONCLUSION AND POLICY RECOMMENDATIONS This study emirically investigated the imact of services and manufacturing Foreign Direct Investment (FDI) on economic growth in the resence of macroeconomic instability and rivatisation over eriod of 1972 to In order to find out the order of integration, we used ADF and PP unit root tests. Autoregressive distributed lag model (ARDL) is used for the robustness of long-run relationshi between the variables. We found that in the long run MFDI and SFDI significantly affect economic growth. However, in the short run, both MFDI and SFDI do not significantly affect economic growth. Moreover, the magnitude of services sector FDI is greater than manufacturing sector FDI. Whereas, the variable of macroeconomic instability significantly affect economic growth both in long run as well as in short run. The coefficient of inflation is ositive in the short run. This is due to the fact that an increase in the rices increases the rofit margin of the roducers in the short run. However, in the long run due to decreased real income of the general masses, it hamers economic growth. Private investment is also heling to boost the economic growth. The results also show that in the resence of rivatisation olicy, FDI contribute to economic growth. However, this contribution is more in services sector as comared to manufacturing sector. As regards the olicy recommendation, roer attention should be aid roer to strengthen manufacturing sector that is real sector of economy. In case of services sector government should attract FDI toward infrastructure base services sector so that it may hel to contribute the growth of manufacturing sector in the long run. FDI should be encouraged to amlify economic growth, to amlify benefit of innovative technology to curtail overty and unemloyment, to lift u living standards but at the mean time roer attention should also be aid to save sovereignty and rofit outflow of the country. In order to enhance growth, olicies should device to attract exort oriented FDI instead of domestic demand oriented.

7 S.N. Variables 1. Market Growth (GDP) 2. Investment (INV) 3. Macroeconomic Instability (INF) 4. Manufacturing FDI (MFDI) + 5. Services FDI (SFDI) 6. Privatisation (Dummy) Sector Level Analysis of FDI-Growth Nexus 881 Aendix Aendix Data Descrition and Sources Exected Sign in Literature Data Sources and Descrition GDP growth is used as deendent variable. + Data is obtained from SBP annual reort. Investment is roxied as GFCF. Data is +/ obtained from hand book on statistics on Pakistan economy (Various issues). Macroeconomic instability is roxied by inflation variable. Data on inflation is taken from WDI (2008) electronic database. _ + Manufacturing FDI is calculated by adding the FDI coming towards all the manufacturing units. Source: Foreign liabilities and assets and investment in Pakistan (Various Issues). Services FDI is including FDI in infrastructure based services sector. Source: Foreign liabilities and assets and investment in Pakistan (Various Issues). Privatisation is taken as dummy.1 for years rivatisation was taken, 0 otherwise. REFERENCES Aitken, B. and A. E. Harrison (1999) Do Domestic Firms Benefit from Direct Foreign Investment? Evidence from Venezuela. American Economic Review 89:3, Alfaro, L. (2003) Foreign Direct Investment and Growth: Does the Sector Matter? Harvard Business School, Boston, MA. (Mimeograhed). Atique, Z., M. H. Ahmad, and U. Azhar (2004) The Imact of FDI on Economic Growth under Foreign Trade Regimes: A Case Study of Pakistan. The Pakistan Develoment Review 43:4. Bengoa, M. and B. Sanchez-Robles (2003) Foreign Direct Investment, Economic Freedom and Growth: New Evidence from Latin America. Euroean Journal of Political Economy 19:3, Blomström, M. and A. Kokko (2003) Human Caital and Inward FDI. The Euroean Institute of Jaanese Studies. (EIJS Working Paer Series. No. 167). Blomström, M., R. E. Lisey, and M. Zejan (1994) What Exlains Develoing Country Growth? (NBER Working Paer No. 4132). Borensztein, E., J. De Gregorio, and J. W. Lee (1998) How Does Foreign Direct Investment Affect Economic Growth? Journal of International Economics 1:45, Caves, R. (1974) Multinational Firms, Cometition and Productivity in Host-Country Markets. Economica 41:162, Enderwick, P. and M. Akoorie (1996) Fast Forward: New Zealand Business in World Markets. Longman Paul, Auckland.

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